Chapter 8. Cost Estimation and Budgeting

Chapter 8. Cost Estimation and Budgeting

Sochi Olympics—What’s the Cost of National Prestige?

The Sochi Olympics was an example of project costs running out of control; so much so that the final price tag (estimated to be more than $50 billion), dwarfed the costs of every other Olympic Games to this point in time. In addition to picking a questionable, sub-tropical location for the Games, from the very beginning, the process of developing the site was subject to meddling from politicians, including President Vladimir Putin. Another major cost to the final price tag was related to charges of wide-spread corruption, as sub-projects for the Games (such as infrastructure, buildings, and roads) ended up with highly inflated price tags. This is a great case for general class discussion as we consider the purpose for Olympic Games, the challenges of cost control with critical deadlines that must be adhered to, and the fact that costs are rising for Games to the point where in 2017, Rome, Budapest, and several other cities withdrew their bids to host the 2024 Olympics because they could not trust the final costs and could not justify the value they would gain versus the costs of the project.

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Questions

Consider the following statement: “Government-funded projects intended to serve as ‘prestige projects,’ such as the Sochi Olympics, should not be judged on the basis of cost.” Do you agree or disagree with this statement? Why?
Project success is defined as adherence to budget, schedule, functionality (performance), and client satisfaction. Under these criteria, cite evidence that suggests the Sochi Olympics project was a success and/or failure.
When a project has a “hard gate,” like being ready on time, how does that affect normal success criteria? Is it fair to judge a project with a critical completion date by normal project success standards? Why or why not?

Consider the problems with the Rio Olympics sites that quickly occurred following completion of the 2016 Summer Games. Access the internet to find evidence of the current state of the Sochi Olympic site. How is it being used and what are the current problems and opportunities for Sochi?Project Management: Achieving Competitive Advantage

Fifth Edition

Chapter 8

Cost Estimation and Budgeting

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Learning Objectives

8.1 Understand the various types of common project costs and key differences between them.

8.2 Apply common forms of cost estimation for project work, including ballpark estimates, definitive estimates, parametric estimates, and learning curve.

8.3 Apply top-down, bottom-up, activity-based, and time-phased budgeting procedures for cost management.

8.4 Recognize the appropriateness of applying contingency funds for cost estimation.

P M B o K Core Concepts

Project Management Body of Knowledge (P M B o K) covered in this chapter includes:

Plan Cost Management (P M B o K 7.1)

Estimate Costs (P M B o K 7.2)

Determine Budget (P M B o K 7.3)

Control Costs (P M B o K 7.4)

Cost Management

Cost management has been defined to encompass data collection, cost accounting, and cost control.

Cost accounting and cost control serve as the chief mechanisms for identifying and maintaining control over project costs.

Cost estimation processes create a reasonable budget baseline for the project.

Common Sources of Project Cost

Labor

Materials

Subcontractors

Equipment and facilities

Travel

Types of Costs

Direct Versus Indirect

Recurring Versus Nonrecurring

Fixed Versus Variable

Normal Versus Expedited

Figure 8.2 Project Price Breakdown

Table 8.2 Cost Classifications

Cost Estimation

Ballpark (order of magnitude)

Comparative

Feasibility

Definitive

Learning Curves

Each doubling of output results in a reduction in time to perform the last iteration.

Where :

Yx = the time required for the x unit of output

a = the time required for the initial unit of output

X = the number of units to be produced

b = learning curve slope

Figure 8.6 Unit Learning Curve Log-Linear Model

Software Project Estimation—Function Points

Function Point Analysis is a system for estimating the size of software projects based on what the software does.

Function Points are a standard unit of measure that represents the functional size of a software application.

Figure 8.7 Software Project Development Activities as a Function of Size

Table 8.4 Complexity Weighting Table for Function Point Analysis

Table 8.5 Function Point Calculations for Restaurant Reorder System

Problems with Cost Estimation

Low initial estimates

Unexpected technical difficulties

Lack of definition

Specification changes

External factors

Creating a Project Budget

The budget is a plan that identifies the resources, goals, and schedule that allows a firm to achieve those goals.

Figure 8.8 The Relationship Among W B S, Scheduling, and Budgeting

Top-down

Bottom-up

Activity-based costing (A B C)

Activity-Based Costing

Projects use activities and activities use resources.

Assign costs to activities that use resources.

Identify cost drivers associated with this activity.

Compute a cost rate per cost driver unit or transaction.

Multiply the cost driver rate times the volume of cost

driver units used by the project.

Table 8.6 Sample Project Budget

Activity	Direct Costs	Budget Overhead	Total Cost
Survey	3,500	500	4,000
Design	7,000	1,000	8,000
Clear Site	3,500	500	4,000
Foundation	6,750	750	7,500
Framing	8,000	2,000	10,000
Plumb and Wire	3,750	1,250	5,000

Table 8.7 Sample Budget Tracking Planned and Actual Activity Costs

Activity	Direct Costs	Budget Overhead	Total Cost
Survey	4,000	4,250	250
Design	8,000	8,000	– 0 –
Clear Site	4,000	3,500	(500)
Foundation	7,500	8,500	1,000
Framing	10,000	11,250	1,250
Plumb and Wire	5,000	5,150	150
Total	38,500	40,650	2,150

Table 8.8 Example of a Time-Phased Budget

Activity	January	February	Months March	April	May	Total by Activity
Survey	4,000	Blank	Blank	Blank	Blank	4,000
Design	Blank	5,000	3,000	Blank	Blank	8,000
Clear Site	Blank	4,000	Blank	Blank	Blank	4,000
Foundation	Blank	Blank	7,500	Blank	Blank	7,500
Framing	Blank	Blank	Blank	8,000	2,000	10,000
Plumb and Wire	Blank	Blank	Blank	1,000	4,000	5,000
Monthly Planned	4,000	9,000	10,500	9,000	6,000	Blank
Cumulative	4,000	13,000	23,500	32,500	38,500	38,500

Figure 8.9 Cumulative Budgeted Cost of the Project

Budget Contingencies

The allocation of extra funds to cover uncertainties and improve the chance of finishing on time.

Contingencies are needed because:

Project scope may change

Murphy’s Law is present

Cost estimation must anticipate interaction costs

Normal conditions are rarely encountered

Benefits to Contingency Funding

Recognizes future contains unknowns

Adds provision for company plans for an increase in project cost

Applies contingency fund as an early warning signal to a potential overdrawn budget

Summary

Understand the various types of common project costs and key differences between them.

Apply common forms of cost estimation for project work, including ballpark estimates, definitive estimates, parametric estimates, and learning curve.

Apply top-down, bottom-up, activity-based, and time-phased budgeting procedures for cost management.

Recognize the appropriateness of applying contingency funds for cost estimation.

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Chapter 8. Cost Estimation and Budgeting

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